The Mortgage Interest Tax Deduction After a Refinance

Closeup of a tax return, a pen, and a calculator

Tetra Images / Getty Images

Changes in tax law went into effect on January 1, 2018 with the Tax Cuts and Jobs Act (TCJA) that significantly affected the tax deduction for interest on a mortgage refinance loan. The rules aren't as generous as they were in 2017, so you might want to bring yourself up to date before you consider refinancing your mortgage unless you have a pressing need for the money.

You can no longer use the funds for anything other than your home—at least not if you want to claim the tax deduction.

The majority of these changes are set to expire at the end of 2025 when the TCJA sunsets unless Congress reauthorizes the Act or renews certain aspects of the legislation.

Mortgage Date Milestone: December 15, 2017

The 2018-2025 deduction rules apply to the refinancing of an initial mortgage that was completed after December 15, 2017. Mortgages entered into before this date are grandfathered in.

The TCJA rules regarding refinancing don't apply unless the initial mortgage went into effect on or before that date, and the new loan can't exceed the amount of the original mortgage.

How the Money Most Be Used

Whether borrowers are entitled to deduct interest on a loan in excess of their existing mortgage additionally depends on how they use the proceeds of the refinancing and the amount of the proceeds.

Under the rules for home acquisition loans, interest payments fall can be deducted if borrowers use the loan proceeds to buy, build, or substantially improve a principal residence or a second home. The change in the old law requires that home equity proceeds be used only for this purpose in order to be deductible. Previously, the proceeds from the home equity loan could have been used on anything.

Related tax law prohibits deductions for payments of interest on consumer loans when borrowers use the excess amount for any other purpose.

Home Equity Loans vs. Consumer Loans

The wide-ranging category of "consumer loans" includes using the money to pay down credit card bills, auto loans, medical expenses, and other personal debts such as overdue federal and state income taxes.

There's a limited exception for interest on student loans, however, depending on your income.

Most borrowers were previously able to sidestep these restrictions on deductions for consumer interest, thanks to the pre-2018 rules for home equity loans.

Limits on Mortgage Indebtedness

Borrowers can deduct home mortgage interest on the first $750,000 of indebtedness—or $375,000 if they're married but filing separate returns—according to the Internal Revenue Service. A higher limitation of $1 million, or $500,000 each if married filing separately, applies if you're deducting mortgage interest from indebtedness that was incurred before December 15, 2017.

The old rules allowed taxpayers to deduct interest on an additional $100,000 of indebtedness, or $50,000 each for married couples filing separate returns. The 2018-2025 limit remains at $750,000 or $375,000 each for married couples filing separately when refinanced loans are combined home acquisition loans and home equity loans.

There is again an overall limit of $750,000, or $375,000 each for married couples filing separately, when refinanced loans are partly home acquisition loans and partly home equity loans.

Other Restrictive Rules

The collateral for the loan must additionally be the home for which the improvements were made, and the combined debt on the home can no longer exceed its original cost.

Effect of the Alternative Minimum Tax

Yet another restriction applies to borrowers burdened by the alternative minimum tax (AMT). The tricky rules for this tax still allow deductions for interest payments on home acquisition loans, but they also deny a deduction for interest on home equity loans for first or second homes unless the loan proceeds are used to buy, build, or substantially improve the dwellings.

A Final Warning: You Must Itemize

There's one more bit of bad news here: You must itemize in order to claim this tax deduction. This means filing Schedule A with your Form 1040 tax return, detailing each and every tax-deductible dollar you spent all year. You would then claim a deduction for the total.

You might not mind doing a little extra work at tax time if it's going to save you money, but that might not happen because the standard deduction available to taxpayers increased significantly in 2018, also due to the TCJA. As of 2020, taxpayers are entitled to the following standard deductions:

  • $24,800 for married taxpayers filing jointly
  • $12,400 for married taxpayers filing separate returns
  • $12,400 for single taxpayers
  • $18,650 for taxpayers who qualify as head of household

Taxpayers must choose between itemizing or claiming the standard deduction. They can't do both. So unless the total of your itemized deductions exceeds the amount of the standard deduction you're entitled to, you'd be paying tax on more income than you have to. Both the standard deduction and the total of your itemized deductions subtract from your taxable income.